China Can’t Be a Global Innovation Leader Unless It Does These Three Things

When the Chinese Communist Party’s central committee wraps up the Third Plenum on November 12, 2014, a shift from efficiency to innovation will likely be one of the major planks in its vision for China. The government’s imperatives are clear: It wants to double incomes by 2020 in the face of a declining population of working-age; an appreciating currency, and, relative to other emerging economies, high and rising wages. Promoting innovation is also one of the eight key reform priorities in the “383” plan being circulated by the State Council’s Development Research Center.

Trouble is, realizing the objectives around innovation will be not be easy in China, and will require the Chinese government to surmount a number of formidable hurdles.

Some argue that China is already well on its way to becoming a global innovation power that will rival the US and Europe. The “input” indeed appears impressive: China’s R&D expenditure increased to 1.6% of GDP in 2012 from 1.1% in 2002, and should touch 2.0% by 2020, according to the World Bank. China’s share of the world’s total R&D expenditure grew to 13.7% in 2012, and was second only to that of the US, whose share was 29% in 2012.

At first blush, even the output looks impressive. China is well on its way to doubling the number of patent applications filed with the State Intellectual Property Office, from 1 million in 2010 to 2 million by 2015. However, the vast majority of these applications are for utility model patents that undergo a preliminary examination for formalities rather than substance — a concept that does not exist in the US. According to a Shanghai-based patent attorney quoted by the Economist: “Patents are easy to file but gems are hard to find in a mountain of junk.”

Other measures suggest that the productivity of China’s innovation system is low. In 2012, the share of China-based inventors in patents granted by the US Patent and Trademark Office and the European Patent Office was 1.8% and 1.2%, respectively, versus 20.0% and 19.6% in the case of, say, Japan. Thomson Reuters’ 2013 ranking of the world’s top 100 innovators doesn’t include a single company from China. As Lee Kai-Fu, one of China’s best-known venture capitalists and former president of Google China, recently pointed out, what Chinese entrepreneurs do today is iterative innovation; that is, borrowing an existing idea and tweaking it for the Chinese market.

China accounts for 20% of the world’s population, 11% of the world’s GDP, 14% of the world’s R&D expenditure — but less than 2% of the patents granted by any of the leading patent offices outside China. Further, half the patents that originated in China have been granted to subsidiaries of multinationals. Similarly, China awards more doctoral degrees every year than any other country: Over 60,000 in 2012, up from 12,000 in 2000. What isn’t so well known is that in China, the average time required to complete a doctoral degree is just three years, about half that of the US, and most candidates’ dissertations don’t require the approval of a committee of professors.

Why is there such a big gap between China’s standing on the input versus the output side of the R&D equation? With rare exceptions such as Huawei and ZTE, state-owned enterprises (SOEs) rule the corporate landscape in China. Their primary goal is employment and job creation, not disruptive innovation that may be risky but could create shareholder value. They enjoy privileged access to inputs and don’t have to face much competition, so innovation is not a top priority. That’s also why, other than Huawei and ZTE, there is no Chinese equivalent of an IBM, a GE or a Honeywell.

The allocation of the Chinese government’s R&D funds depends far more on whom you know than what you know. As Yigong Shi and Yi Rao, deans of life sciences at Tsinghua and Peking Universities, respectively, observed in an editorial in Science magazine, when it comes to government grants, “it is an open secret that doing good research is not as important as schmoozing with powerful bureaucrats and their favorite experts… China’s current research culture… wastes resources, corrupts the spirit, and stymies innovation.”

China’s R&D culture suffers from a focus on quantity over quality, the use of local rather than international standards to reward research productivity and grant patents, and a continuing weakness in the enforcement of laws to protect intellectual property. The result is not just a focus on incremental advances, but also the duplication of proven knowledge.

China’s educational system emphasizes rote learning rather than creative problem solving. As Lee Kai-Fu noted: “The Chinese education system makes people hardworking, teaches people strong fundamentals, and makes them very good at rote learning. It doesn’t make them creative, original thinkers.” Iconoclastic minds either are channeled into conventional thinking or “become outcasts and their parents would think they’d gone crazy.”

Innovation thrives in a culture of diversity where people don’t feel the compulsion to fit in and where those with strong backbones are likely to be viewed as heroes. Unlike the US, especially Silicon Valley, which thrives on a diversity of ethnicity, national backgrounds, cultures, and languages, China is largely a sea of homogeneity.

Many Chinese executives seem to recognize the challenges. Over the last two months, we conducted workshops for three groups of senior executives from some of China’s largest state-owned enterprises. An anonymous survey shows that over half the executives believed that China would have a bigger economic power than the U.S. in 2025. However, only 13% believed that China would have overtaken the US on the technology frontier by then.

The desire of the new Chinese leadership to make the country a global leader in innovation is laudable, but to ensure that happens, they must focus on three areas:

Allow top-tier scientific panels rather than bureaucrats to allocate government funds for R&D.

Force SOEs to face the winds of competition more fiercely than in the past, and

Recognize that while a weak intellectual property regime may provide some help in the transfer of technology from abroad, it creates a serious disincentive to genuine innovation by top Chinese talent.

The issue then is whether the Chinese government will be able to bring about those reforms soon or whether they will have to wait for another generation of leaders.

Anil K. Gupta is the Michael Dingman Chair in Strategy, Globalization and Entrepreneurship at the University of Maryland’s Smith School of Business. Haiyan Wang is the managing partner, China India Institute.